NEW YORK, March 27 The euro fell to its lowest
level against the U.S. dollar in four months on Wednesday,
weighed by a weak Italian bond auction and concerns that Cyprus'
recent rescue deal could serve as the pattern for future
bailouts in the region.

Italy paid more to borrow over five years than it has since
October as lack of progress in forming a new government and
worries about Cyprus' bailout hurt demand at a debt auction.

Italian center-left leader Pier Luigi Bersani will report to
President Giorgio Napolitano by Thursday on the outcome of talks
with other parties about forming a government.

Cyprus, meanwhile, will impose a ban on cashing checks and
limit the amount of cash that can be taken out of the country as
part of a series of measures to avert a run on the country's
banks when they reopen on Thursday, the central bank said.

Cyprus and the European Union, European Central Bank and the
International Monetary Fund agreed Monday to restructure the
country's two largest banks, forcing shareholders and large
depositors at the Bank of Cyprus and Popular Bank of Cyprus to
take losses in return for a 10-billion-euro bailout.

"The past few days have been mired by endless speculation
over the precedent the bailout of Cyprus might set for other
peripheral countries," said Christopher Vecchio, currency
analyst at DailyFX in New York.

The euro last traded at $1.2776, down 0.65 percent on
the day and off over 3 percent this year. The euro fell as low
as $1.2750, its lowest since Nov. 21.

A bleak outlook for the euro zone's economy and the risk of
capital flight should continue to weigh on the euro.

The euro's drop below support at its 200-day moving average
of $1.2881 on Tuesday left it vulnerable to more losses toward
its mid-November low of $1.2661, traders said.

Investors bought the safe-haven dollar, pushing the dollar
index against major currencies to a 7-1/2 month high.

"It is the risk-of-capital flight out of Cyprus that is
worrying," said Mankash Jain, head of FX and investment
management at hedge fund Solo Capital in London. "Investors
would want to hold the dollar or German Bunds in such a
scenario. We see the euro going only one way - and that is
down."

EU and ECB officials have sought to quash the suggestion
that the Cyprus bank restructuring was a template for future
bank bailouts in the euro zone.

The spread between the yields on two-year U.S. Treasuries
and their German counterparts has widened
to its highest since late December in favor of the former. That
is likely to support the dollar, traders said.

"Cyprus is certainly still weighing on the euro, but the
bulk of the move lower today was triggered by the Italian debt
auction," said Greg Anderson, G10 strategist at CitiFX, a
division of Citigroup in New York.

"Rising Italian borrowing costs and its political situation
are both negatives," he said. "Investors are not overly short
the euro, so there is plenty of scope for the euro to test the
lows of the past cycle."

UPCOMING BOJ MEETING EYED

The yen fared well against the euro as investors preferred
the safest, most liquid currencies, given the troubles in the
euro zone. The euro last traded down 0.66 percent at 120.63
yen.

Against the dollar, the yen should continue to weaken on the
prospect of aggressive monetary easing measures by the Bank of
Japan next week. Nikkei business daily said the central bank
will boost bond buying at its meeting on April 3-4.

Sources also told Reuters the BOJ would likely start
open-ended asset purchases immediately rather than in 2014, as
originally agreed in January, and also buy longer-dated bonds.

But with aggressive easing by the BOJ widely expected, there
is a risk that it could fall short and then the yen could
recover some lost ground.

The dollar last traded at 94.43 yen, up just 0.02
percent for the day, according to Reuters data.

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